With earnings season ramping up across both the US and ASX markets, volatility is back on the menu.
From the Nasdaq heavyweights to S&P/ASX 200 Index (ASX: XJO) stalwarts, results and forward guidance can drive wild share price swings. A company might deliver record profits and still fall on weak forecasts. Others might surprise to the upside and soar. But in many cases, it's not just the results moving the market—it's our psychology reacting to them.
Investing is as much about mindset as it is about numbers. With that in mind, here are three psychological biases investors should be aware of this earnings season.
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1. Anchoring bias
Anchoring bias occurs when investors place too much emphasis on a reference point, usually the price they paid for a stock. Instead of objectively reassessing based on updated fundamentals, we compare everything back to our original entry point.
Take Telix Pharmaceuticals Ltd (ASX: TLX) as an example. If you bought in at $20 and it drops to $15, it's tempting to think of it as a '$20 stock' on sale. But the company's valuation today reflects all known risks and opportunities. Anchoring to the past can cloud your judgment and delay rational decisions, especially if results disappoint.
Instead, consider asking: "If I didn't own this today, would I buy it at this price?"
2. Endowment effect
Another bias that trips up investors is the endowment effect: the tendency to assign greater value to something simply because you own it.
This often surfaces with 'first-love' stocks or those that align with your personal values. Say you bought shares in Pilbara Minerals Ltd (ASX: PLS) early in the lithium boom. Even as prices have cooled and sector headwinds have emerged, some investors might hold on too tightly because they feel emotionally invested in the story.
To combat the endowment effect, it's useful to set clear sell criteria for each individual company you invest in. That might include slowing revenue growth, deteriorating balance sheet quality, or missing earnings per share targets in a row.
3. Recency bias
When the last thing you saw was a big earnings beat, it's natural to assume the good times will keep rolling. Recency bias leads investors to place too much weight on the latest information—whether that's positive or negative.
For example, DroneShield Ltd (ASX: DRO) shares have surged over 120% this past 12 months after a string of large contract wins. While its long-term outlook may still be exciting, investors must be cautious not to extrapolate recent success forever. As with all high-growth stocks, results need to keep pace with expectations.
Similarly, a single disappointing half-year result shouldn't automatically sink your confidence in a company you've researched deeply. Balance short-term results with long-term conviction.
Foolish Takeaway
As the ASX reporting season kicks off, it's worth checking your emotional pulse before acting on headlines. Awareness of common psychological traps like anchoring, endowment, and recency bias can help you stay grounded and focused on fundamentals.
